The area of professional liability has been a volatile one in the United States for the last few decades. The problems began in the early 1970s when the medical malpractice crisis erupted. By the end of that decade, directors and officers liability insurance became a problem and then, in the 1980s, the problem grew and moved into other lines such as architects liability and lawyers liability.
The professional liability market in the U.S. is still volatile today, with a society hell-bent on suing, sometimes even for the slightest of wrongs; and plaintiffs' attorneys are only too eager to accommodate litigants' desires to catch the brass ring for a free ride.
In overseas markets, however, professional liability problems have not been so apparent. For one thing, overseas markets have not yet developed the "lawsuit mentality" that dominates this country. For another, other parts of the world do not have the equivalent of our contingency fee system which makes it easier to gain access to the court system.
There are signs, however, that things may be changing. This year, at the annual PLUS (Professional Liability Underwriting Society) convention, some speakers gathered to discuss professional liability in Latin America. One speaker was Robert A. Vernon, assistant vice president in charge of the Financial Lines Group for Reliance National Argentina. Said Vernon:
"As the world's financial markets become increasingly interrelated and dependent on one another, the risks of conducting business whether at home or abroad become more difficult to quantify. No longer can managers label their companies as being domestic or international, but rather must refer to the increasingly popular adjective 'global' when describing their business. It is generally understood that to effectively compete in this new global market, one needs to consider all of the different political, economic, and cultural issues of the world which could impact an organization.
"However, when considering the legal issues and, specifically, the potential liabilities of business, very often managers fail to apply that same global perspective. Litigation, historically, has not been much of a cross-border issue, mostly due to the differences in the legal systems and the specific laws governing a country's business environment. Today this is changing."
Vernon said that foreign direct investment is rising at drastic rates particularly in emerging economies, which naturally creates a heightened awareness and scrutiny of the activities of the local markets and specifically the people who manage them. For this reason professional liability insurance will become a necessity for all businesses participating in the global market, he said.
Vernon noted that professional liability standards are well-defined in economically developed countries such as the United States and parts of Europe and are considered to be "quite high" relative to other parts of the world. Is this professional standard expected to increase in other countries, specifically in Latin America? Vernon says "yes." He pointed to just one area as an example, directors and officers liability.
"The origins of directors and officers liability insurance can be traced back to London in the 1960s, where many nontraditional insurance products were developed," he said. "A few major corporations purchased insurance for their directors and officers to protect their personal assets in the event their company was not able or permitted to fulfill its indemnification agreements. As competition is inevitable, it wasn't long before other large insurance companies followed Lloyd's lead and began to write similar policies. The policies were generally for large limits over multiple years for relatively small premiums. The market grew modestly over the next several years as some directors and officers decided to purchase the coverage, or what was then referred to as 'sleep easy' insurance because of the presumably low exposure. In 1984, the D&O industry saw its first major claim, which settled for somewhere in the area of $40 million. The severity of this case brought panic to the insurance market as insurers realized the underwriting criteria and pricing was way off. Most of the carriers who were underwriting D&O cut the product altogether and the few who remained drastically reduced limits and increased premiums.
"Professional liability today is a global issue and one that all directors, officers and professionals should take very seriously."
--Robert A. Vernon, assistant vice president, Financial Lines Group, Reliance National, Argentina
"This single claim changed the face of D&O liability and the entire securities litigation environment in the U.S. and around the world," said Vernon. "Since 1984, the number of securities claims filed in the U.S. has increased dramatically. According to Securities Class Action Alert (SCAA), published by Investors Research Bureau, in 1997 alone, there were an estimated 187 federal filings and 57 state filings of securities action claims. The 1996 Watson Wyatt Worldwide D&O Liability Survey report stated that the average settlement value for a shareholder claim was $7,238,338. This number excludes defense costs, which run on average higher than $2 million per claim. There have been many efforts to curb the number of securities lawsuits filed in the U.S., most notably the Securities Reform of 1995, yet the number of claims filed annually in federal court has changed very little. Additionally, the number of state court filings has increased in an effort to circumvent the new Securities Act."
The reason the number of lawsuits began increasing, said Vernon, is that, in addition to the sophisticated "high-rolling" investors dominating the market, new investors appeared. "By the mid- to late '80s, with the U.S. economy booming and the savings rate increasing, a new set of less experienced investors emerged, placing the risk of business in the hands of the average American. No longer were small-time investors content with the interest rates provided by simple savings accounts. They wanted a piece of the action, investing in stocks and bonds. However, the concept of risk/reward wasn't common knowledge and many of these new investors were burned. Whether these newcomers were actually defrauded or simply lacked the expertise or knowledge to successfully play the stock market did not matter. They were looking for restitution and found it in the Class Action Securities Claim, a way to bridge the gap between small investors and giants, a way to even the playing field, ultimately a way for small plaintiffs to band together and fight the big guys," Vernon said.
The Reliance executive said that when tracing the evolution of D&O liability and securities litigation in the U.S., one notices "extreme similarities" between the present state of financial markets in Latin America and its surrounding legal environment to that of the U.S. In the recent past, economies of Latin America have been in a state of restoration and repair. The investor pool has been made up mostly of well-capitalized, sophisticated institutional investors, and the risks and level of expectation were well-understood.
However, said Vernon, today countries like Argentina, Brazil, and Chile are well past the reparation phases and are beginning to attract a significant amount of investment interest both at home and abroad. Total direct foreign investment since 1990 has reached approximately $120billion in Latin America, and this number is expected to double by early in the next millennium. Additionally, by the year 2000 it is expected that private pension funds in Latin America will have assets of roughly $250 billion. Companies looking to access capital through public offerings will see their valuations skyrocket, as more dollars chase additional investment opportunities.
As the local financial markets grow, a higher degree of regulation also will be needed to prevent system abuses and maintain both foreign and local confidence. Regulation, public scrutiny, and larger pools of less sophisticated investors are the keys to increased litigation. Foreign and local plaintiff attorneys alike will undoubtedly see the potential lucrative market in defending less savvy investors against Latin American companies and their managers, Vernon said.
"What does all this mean to the clients, brokers, and carriers of the insurance industry in Latin America? Professional liability is increasing locally and will continue to increase as the effects of globalization continue. Very few businesses operate today without some impact from international markets. One only needs to read the headlines to realize the impact Asia, Europe, or the U.S. will have on the economies of Latin America. For professionals, acquiring the knowledge to make educated risk management decisions regarding professional liability is essential. Professional liability today is a global issue and one that all directors, officers, and professionals should take very seriously," he said.
Currently, only a handful of insurance companies in Latin America has the ability and expertise to develop and underwrite products such as directors and officers liability and errors and omissions liability for lawyers, notaries, travel agents, etc. Some companies have set up marketing offices to establish contacts with local producers, and then outsource the underwriting and claims handling back to a home office in the U.S. or Europe. Few companies have established a full-service financial lines unit with local underwriting, claims, and product development authority, which is an important issue to consider when making purchasing decisions. As the professional liability product continues to evolve, it is important to have a local resource who can recognize changes specific to the Latin American market and can adapt products and policies to meet the needs of local clients and producers.
Said Vernon: "As the insurance brokers around the world continue to consolidate, there is an increasing effort to commoditize the traditionally specialized financial lines of insurance. Time-strapped brokers with increased production pressures are quick to highlight price as the number one consideration in choosing coverage. Clearly, price is an important issue; yet when you consider that the average class action settlement including legal costs is roughly $10 million, the cost of a typical contract is rather small. Global underwriting expertise, litigation management, and claims handling experience should be the top priorities of any educated broker or buyer. As professional liability is a severity cover, many clients, and brokers as well, have not experienced a claim. A cheap policy can look great in your top desk drawer, but it isn't worth the paper it's written on if a claim is not paid or the process not managed properly to escape with the minimum cost." *
©COPYRIGHT: The Rough Notes Magazine, 1999